Mexico’s Power Sector Attracts New Investors

Forget sluggish economies in the United States, the European Union, and certain Asian countries; Mexico has emerged as a lightning rod for international infrastructure investment. As energy investors assess changing global opportunities, Mexico continues to offer numerous stable investment prospects. Mexico’s investment-grade credit rating provides potential investors one of the few high-grade investment environments in Latin America.

The Mexican economy has been bolstered by the strong international demand for its commodities and a competitive labor force favored by numerous U.S. industries, following a reevaluation of a production chain previously outsourced to China.

As a result, continued economic growth has strained Mexico’s power generation and transmission systems. So the long-term relative stability of Mexico’s economy provides investors with safe, profitable power sector development opportunities. Savvy political technocrats in the country are using the investment window to attract foreign investors.

With a change in administration following last year’s presidential election and a push by the federal government to further modernize the country’s infrastructure, Mexico’s power sector will continue to provide opportunities for private equity investors, development companies, construction companies and lending institutions. One of the challenges is to understand the inherent risks of investing and operating in Mexico.

During the 1980s and 1990s, Mexico was a darling of the investment community. Many region-specific private equity funds emerged. Infrastructure development companies formed dedicated Latin American teams. But as competition for infrastructure development grew and profit margins declined, investors and developers soon turned to other markets—such as Eastern Europe, Russia, the Middle East and Asia—that were experiencing infrastructure development booms and offering more profitable investment opportunities.

Investors and developers also looked to the U.S. and Europe, which were also experiencing economic prosperity and an aggressive infrastructure build-out. With this shift in regional focus, many private equity players and developers deemphasized their capital deployment efforts in Latin America and disbanded their “LatAm” teams.

The demise of these region-focused teams meant a loss of institutional knowledge for these firms and an opportunity for smaller regional developers to gain a foothold in Mexico. Now, as large institutional players return to the region, successful firms will need to retain external advisers with a deep knowledge of the Mexican market in order to judge market opportunities and investment risks.

The sharp reduction in power sector opportunities in the U.S. and Europe has catalyzed recent interest in Mexican power. Mexico’s power sector has attracted attention from foreign investors, who have developed large fossil fuel-fired power plants, the culmination of 20 years of work by the country to leverage its strong credit rating and stable economic growth to attract investors.

In the early 1990s, the Mexican government embarked on a massive infrastructure build-out program in its electricity sector. Mexico developed a well-defined legal framework to permit private investors to participate in the development and ownership of power generation facilities to supply the national electric utility, Comisión Federal de Electricidad (CFE), as well as large direct industrial customers. The CFE independent power project (IPP) program has become one of the most effective international power plant development programs anywhere in the world. 

The speed of power plant deployment and the low costs associated with the long-term energy pricing of the power plants demonstrate the competitive and transparent bidding environment that CFE has been able to foster. CFE’s IPP program allowed the government to refocus its own capital investments in the national transmission grid. 

Private sector thermal power plant developments are the foundation of Mexico’s modernized power sector. By promoting gas-fired plants to replace aging diesel and oil-fired units, Mexico has achieved cleaner-burning facilities and reduced the country’s carbon footprint and inventory of conventional pollutants. Controlling the size and locations of the plants in each IPP request for proposals, CFE has been able to strategically leverage private investor funds to meet the public demand for electricity in regions of the country in greatest need of additional power generation capacity. During the last 18 years of Mexico’s IPP program, CFE has targeted power generation development in the most critical power starved regions of the country.

An unintended shortcoming of CFE’s otherwise successful IPP program has been pressure on the country’s natural gas supply. During the course of two decades, Mexico moved from a natural gas exporter to a net importer. Natural gas demand has increased to the point that Mexico has had to promote liquefied natural gas regasification facilities throughout the country (including in Altamira, Baja California, and Manzanillo) to augment its domestic supplies. In order to accommodate new entry points for natural gas supplies, the Ministry of Energy will need to expand Mexico’s vast pipeline network.

Similar to the activity in the U.S., Mexico has seen a surge in activity surrounding renewable energy. CFE has been addressing issues of wheeling power, which hindered the past development of renewable power projects. CFE’s preexisting wheeling structure failed to account for wind’s intermittent nature and penalized wind power projects for failing to produce a stable constant electricity supply. Today, CFE’s wheeling arrangements account for wind power’s intermittent nature. CFE has created a system where a renewable energy project can “bank” excess energy production during periods when an off-taker does not require energy from the project and allow the user to access the “banked” energy during periods that the power project does not produce sufficient energy to meet its energy needs. Additionally, postage-stamp wheeling charges earmarked solely for renewable energy have benefited renewable energy production. As a result, buyers of wind power see power rates that directly compete with fossil-fuel generated energy.

The true test of whether the projects are viable is determining if third party non-recourse financing is available. In Mexico, commercial lending institutions are actively looking for lending opportunities to well-structured infrastructure projects. Multilateral lending institutions, such as the International Finance Corp. (IFC) and the Inter-American Development Bank (IADB) are also working in the Mexican market with creative financing structures.

In addition to multilateral financing institutions and commercial lenders, international development banks, such as FMO (the Netherlands) have supported infrastructure projects that promote certain economic, environmental or social objectives. Some international development banks have even prioritized the Mexican market as a target lending environment in order to spur the development of certain projects, such as renewable energy power plants. 

Dino T. Barajas
is a partner in the Corporate Practice group of the law firm Akin Gump Strauss Hauer & Feld LLP specializing in project finance and Latin American transactions.

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